8 November 2013
I always wake up to BBC Radio 4's "Today" programme. On 29 October 2013 I was pleasantly surprised by a story trailing the speech that Prime Minister David Cameron was going to make at the opening of the World Islamic Economic Forum later that day. The BBC stated that Mr Cameron was going to announce that the UK would issue a sovereign sukuk.
Shortly afterwards when I went downstairs to my mobile phone which is always charged overnight, I had text messages from two people asking me to ring them.
She interviewed me by telephone and quoted me several times in her front page story in the 30 October 2013 edition of Islamic Finance News.
"The UK government has a lot of experience with conventional debt, and were able to borrow all the money they needed without Islamic finance," explained former head of Islamic finance at PwC, Mohammed Amin, to Islamic Finance news. "The DMO [UK Debt Management Office] study said it wouldn’t be cost effective, based on a survey of Middle East banks that showed high funding costs which would make it uneconomic for them to invest in return comparable with UK conventional gilts, but the details were never made available – I’ve always suspected it was less a question of money and more about domestic politics."
The decision had an impact on the wider industry, which lost confidence in one of the few non-Muslim majority countries to have demonstrated real and consistent support for Islamic finance. "The world saw the UK as a real pioneer for Islamic finance," said Mohammed. "But then it seemed to run out of steam – mainly because it would never go forward with a Sukuk issuance."
"So many countries have talked about it and nothing has ever happened – it was very frustrating," said Mohammed. "So for the UK to actually move forward and do something sends a really important statement, which will have a material impact even if we aren’t talking big amounts of money."
"If regulators are saying the banks must hold more short-term paper but at the same time there is nothing for the Islamic banks to invest in, then clearly that makes a Catch-22 situation," pointed out Mohammed.
However the most likely denomination for a UK issuance is of course sterling, which raises concerns that this could put off investors who are not interested in holding UK currency. "If you’re a Sukuk investor located in the Middle East then unless you think sterling is undervalued, you are unlikely to be interested," pointed out Mohammed.
Paul explained that he was going to re-run a piece written in 2008 when he was an MP and part of the team shadowing the Treasury. The then Conservative opposition had asked the Labour government some challenging questions about the Finance Bill 2008 clauses [see Finance Act 2008 Schedule 46] which were intended to give the Government enabling powers to make regulations to facilitate issuing a sukuk. I reminded him that while at PwC I had been involved in providing a technical background briefing on the legislation to the Conservative shadow Treasury team.
Fortunately I was at home and had a free morning. Accordingly I agreed to supply a piece for Conservative Home which was published that afternoon. It is reproduced below, with Paul's summary of the original 2008 questions highlighted in pink text.
I have also since written the piece "A simple introduction to sukuk."
Mohammed Amin is Deputy Chairman of the Conservative Muslim Forum. He is also an Islamic finance consultant and before retirement was UK Head of Islamic Finance at PricewaterhouseCoopers LLP. He is writing in a personal capacity.
Modern Islamic banking began with a few tiny Islamic banks in Egypt in the late 1960’s. From that small start it has been growing steadily, and now there are several hundred Islamic financial institutions around the world, with global Islamic financial assets of around $1.5 trillion. That figure looks dramatic until you remember that it represents less than 1% of global financial assets. As Muslims are about 23% of humanity, there is plenty of scope for further growth in Islamic finance.
The Labour Government under Tony Blair and Gordon Brown made a number of changes to UK tax and regulatory law to promote Islamic finance. The overall policy was aimed at ensuring that Islamic finance was not taxed or regulated more heavily than conventional finance. While a completely level playing field has not yet been achieved, the legal changes do allow Islamic financial institutions to operate in the UK, and we currently have five stand-alone Islamic banks with others probably in the pipeline.
The Labour Government was driven by two main policy goals:
Fixed return limited life securities backed by sovereigns issuing in their own currency (“government bonds”) play a vital role in financial markets. As an asset normally free from the risk of default, since the sovereign can always print more money to pay them off, they are held by banks for liquidity management purposes, and also provide a risk free interest rate curve for borrowings in that currency.
Accordingly, from late 2006 onwards it was suggested that the UK Government should issue a sukuk. I was there when Ed Balls hosted the first ever meeting of the UK’s Islamic Finance Experts Group at No. 11 Downing Street in April 2007 and launched a formal study regarding a Government sukuk. Enabling legislation was passed in Finance Act 2008, and Paul Goodman has reminded us about the 10 questions the opposition asked at that time. I was involved in briefing our shadow Treasury team at that time regarding the technical content of the legislation.
In October 2008 the Government announced that an issue would not be value for money, and it has repeated that mantra periodically but without ever publishing the detailed value for money study. However the failure to issue a Government sukuk has caused other countries to question whether the UK is really serious about Islamic finance, and such doubts are not good for London’s competitive position. The absence of risk free sterling Shariah compliant paper has also resulted in treasury management challenges for the UK’s Islamic banks. Accordingly a new study has been underway for about a year.
The announcement today was both a nice surprise, and also not a surprise. With the UK hosting the first ever World Islamic Economic Forum held outside a Muslim majority country, today was the ideal day for getting maximum news impact. It follows a financial inclusion based statement at the No 10 Eid Reception last week that the Government will introduce Shariah compliant student loans and start up loans. The size of the issue, £200 million, is obviously calibrated to ensure that all of the issue can be taken up by UK Islamic banks for treasury management purposes, without having to rely upon overseas demand.
I am not privy to the details of what the Government is going to do, but can provide an educated response to Paul’s 10 questions:
1. What sort of assets does Osborne have in mind, given that they themselves must apparently be sharia-compliant? Any sort of Government owned real estate should do. The Government owns little real estate that is not Shariah compliant; I am not aware of any Government owned casinos, distilleries or pig farms!
2. Is the Government proposing to make payments under the terms of the bonds in currencies other than sterling? Given the £200m size, I expect everything to be in sterling.
3. If a special purpose vehicle acts as the issuer of a sukuk bill, and uses the proceeds to acquire the assets which are to be leased, who will control them while they are owned by the vehicle? If an SPV is used, I would expect the Government to either directly control the SPV (for example by making the Public Trustee the trustee) or to pick very friendly directors. (Retired Chancellors of the Exchequer come to mind!)
4. What scale of issuance do Ministers believe is required to bring the price of a sukuk bill in line with that of a conventional one? With an issue of around £200 million, I would expect the pricing to be identical to Treasury bills or gilts of the same maturity.
5. What effects does the Government believe that the issuance of a sukuk product would have on the conventional bill market? Given the tiny size, there should be no impact upon the market for conventional gilts or Treasury bills.
6. Since there are potential risks to the taxpayer in the issuing of sukuk bonds or bills, would it not be best for any proposal to issue them to be contained in a bill which, unlike secondary legislation, can be amended? What risks? I don’t see any.
7. Since it is in the nature of a sukuk bill for holders to share risk, will they in turn demand high returns – leading to high costs for taxpayers? There is no real risk sharing with the type of sukuk likely to be used. The investors will be relying upon HM Government to pay the rent, either directly or indirectly. As we don’t have a Tea Party in the UK, the UK Government can be relied upon to pay its bills.
8. For a product to be sharia-compliant it must be approved by a board of sharia scholars. Which scholars is the Government planning to consult? I assume there will be Shariah scholars who give a fatwa (an Islamic religious/legal opinion) that the structure is Shariah compliant. I would expect the Government to contract this out to the Shariah board of an Islamic advisor, rather than setting up its own Shariah board, which might be politically controversial.
9. Are Ministers planning to make other new uses of structured notes (i.e: means of borrowing money without paying interest?) A wider question, which is not really relevant.
10. What assessment has the Government made of the risks to its standing as a sovereign borrower of the use of structured notes? There should be no impact of any kind on the UK Government’s standing as a sovereign borrower.
Despite its small size, I do expect this announcement, if followed through by an issue, to have a major positive impact on the perception of the UK as the leading country in Islamic finance outside the OIC (Organisation of Islamic Cooperation). Accordingly it will be good for London’s competitive position, and I see no downsides of any kind.